Getting behind on mortgage payments is one of the most uncomfortable situations homeowners can go through. However, people scared of losing their houses after an economic hardship have two ways to avoid that. We are talking about loan modification and refinance.
Both methods try to achieve the same goal: to make mortgage payments more affordable. Regardless of that, loan modification and refinance are completely different from each other since they address different needs.
People outside the real estate niche don't always know the difference between loan modifications and refinances, so we are here to help them with that. Do you wonder if any of those tools can help you get out of your ordeal? Dive into this page to learn when to go for a refinance or for a loan modification!
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Understanding a Loan Modification
You need to know everything you can about loan modifications and how trying one can help you before making any decision. Getting a loan modification consists of asking your current loan servicer to change the terms of your mortgage. Homeowners do this when they face a sudden financial hardship.
The pandemic is the perfect example of that. When COVID-19 stroke, people couldn't go out to work, so sales went down. Thus, homeowners didn't make enough revenue to meet their mortgage payments. Things such as losing your job or your boss cutting your work hours can also force you to change the terms of your existing loan.
It's worth noting loan modifications must be your last resource to avoid foreclosure, so don't try any loan modification programs unless you need them. Since your loan servicer is the only person able to change your existing mortgage terms, you need to convince them to do it.
Although qualifying for a loan modification is not as difficult as qualifying for a refinance, your loan servicer can reject your application if they don't consider you need it. Thus, homeowners need to show loan servicers proof of the emergency that makes it difficult for them to meet the next monthly payment.
These are some of the changes you can make on an existing loan:
- Loan term extension
- Principal reduction
- Interest rate decrease
- Loan type change
If your loan servicer agrees to it, you can make more than one change to your monthly payments. Homeowners can, for example, get a loan term extension and an interest rate decrease. Everything depends on how difficult to overcome your financial hardship is and what you negotiate with your loan servicer.
Legal or financial counsels can help homeowners behind on mortgage payments get into government programs that try to avoid their applicants' foreclosure.
Loan Modification Pros
Loan modifications and refinances have pros and drawbacks that make them more suitable for people going through different circumstances. Here are the reasons a loan modification could help you:
- It doesn't take as much time as a refinance.
- You don't need to pay closing costs.
- It might give you free equity in your home.
- It doesn't require as much paperwork as a refinance.
Loan Modification Cons
Don't expect loan modifications to be all about benefits. Look at some of the cons of trying this alternative to make your next monthly payment more affordable:
- It may lower your credit score.
- You can't take cash out for other expenses.
- You need to prove you can't meet your monthly payments due to a financial hardship.
How Does Refinance Work?
While a refinance also aims to make your mortgage payments more affordable, it does it by replacing your old mortgage with a new one. Therefore, going for a mortgage refinance allows you to shop around, which is something you can't do with a loan modification.
However, replacing your mortgage means you have to be up to date with your current loan and pay its closing costs. After that, you can start handling all the paperwork needed for the process with a legal assistant.
Speaking about paperwork, asking for a refinance needs you to handle more of it than you would do on a loan modification. Most people going for a mortgage refinance hire a financial expert to help them with that.
While you need to prove you are going through a financial crisis when trying a loan modification, going for a refinance only needs you to prove you have enough funds to pay for the monthly mortgage payment of your next loan. Refinance rates are low, so they are an excellent option for people looking forward to saving money on their new loan.
As you could see, a refinance is not something you try when you are behind on your monthly mortgage payment but rather when you want to save money in the long run. This process also lets you take cash out.
The advantages of refinancing your home loan won't be that good for people who don't have enough money to get a new loan. It's better if you see it for yourself, so look at the benefits of asking for a loan refinance:
- It allows you to shop around.
- You can get a new loan with better terms.
- It doesn't affect your credit score.
- It helps you save money.
- You can take cash out.
- It can take you more than 50 days to get a refinance.
- It's more difficult to qualify for a refinance than for a loan modification.
When Should I Go for a Loan Modification?
Now that you know the differences between a loan modification and refinancing, you may wonder which option is better for you. As you could see, asking for a loan modification is better for people facing a financial crisis they didn't foresee.
Do you need a more in-depth analysis of when a loan modification process could fit you? Homeowners should try a loan modification when:
They Are Behind on Their Monthly Mortgage Payments
You can't ask for a refinance if you are behind on your monthly payments, so a loan modification would be one of the only things on the table. Look at it this way: you may not be able to pay for your next monthly payment because the ordeal you are going through doesn't let you get the money you need to pay for what your current mortgage terms require.
Hence, you want home loan terms that adapt to your current financial situation, and that's what a loan modification offers.
If you are behind on your monthly payments, you may need some more time to get the money for them. Getting a loan modification doesn't mean not paying your mortgage debt but making doing it easier for you.
Their Monthly Payment Is No Longer Affordable
As we mentioned before, going for a loan modification is ideal for people who don't have enough money for their current home loan terms.
It may be difficult to catch up on your mortgage debt if you don't have enough money to cover your monthly payment. Even if you were up to date and had enough money for the interest rate, you will get into loan debt if the monthly fee is too expensive for you.
There are many ways to address this through a loan modification. The first of them is to ask your loan servicer to reduce the loan's interest rate. Applying for a principal reduction could also help.
They Go Through a Sudden Emergency
The previous reasons to go for a loan modification could be a consequence of a sudden emergency you couldn't foresee. We used the pandemic example in the past, but illness, wrongful death, a personal injury, or losing your job are also things that could make you unable to pay for your current home loan.
Choosing a mortgage loan modification over a refinance can help you a lot in this case since you have many ways to address the same problem. Remember you won't only get one change to your private mortgage insurance since you can ask your loan servicer to make all the changes you need to help you pay for interest rates and avoid foreclosure.
When Should I Go for a Refinance?
Mortgage refinancing is also an excellent option for many people, but you need to make sure it fits your needs and goals. People with an adjustable rate mortgage or an FHA loan often try getting a new mortgage since it's better than trying to change its terms as they would do with a conventional loan.
You will see some of the reasons you should ask for a refinance instead of a loan modification below, but remember this alternative won't work its best with people facing a financial crisis.
Try refinancing if your situation checks the following boxes:
You Want to Save Money
Most people with an FHA loan struggle to save funds since they have to spend a lot of their money on interest rates. The same happens with people with a mortgage loan with high monthly payments or overall unfair terms. If you want a new mortgage that allows you to save some funds for the future, a refinance is your top choice.
When you get a loan modification, you can only negotiate the new terms of your mortgage with your loan servicer. Refinancing, on the other hand, lets you change your loan type and try a mortgage with more appealing interest rates.
You Have the Money to Get a New Mortgage
You don't have to refinance with your current lender when you want to replace your current mortgage insurance. Nonetheless, you need to be off the hook with your principal balance and interest rate, and if you are not, you need to get money to pay for everything.
Apart from the monthly payment amount you owe your current lender, you also need to pay for its closing costs. Hence, it's best to make sure you have enough money to get a new loan type before trying a refinance.
You Have Home Equity
Home equity is one of the most important factors to consider when choosing between refinancing and loan modification. Your home equity is the difference between what you owe your lender and the current value of your property.
Getting a new loan with a lower interest rate and mortgage payment can help if you have some home equity in your house. The reason for this is equity doesn't change when you refinance your mortgage, so you don't have to worry about that. However, home equity can fluctuate depending on the current real estate market trends.
These are some of the factors that could change your home equity value:
- Crime rates
- Schools nearby
- Unemployment levels
Regardless of that, those things may not be that important for you unless you are looking forward to selling your house any time soon.
Does Loan Modification or Refinance Hurt My Credit Score?
Refinancing doesn't affect your credit score, so it won't count as debt settlement. Hence, people with a high credit score can replace their original loan with no worries. Things change for people asking for a load modification after facing financial difficulty.
Although it's not something that will happen all the time, mortgage modification can reduce your credit score if your loan servicer reports the change to the credit bureaus. Why does that reduce your credit score? Because it shows the bank you are going through a difficult financing situation.
Nevertheless, that shouldn't be a reason to avoid changing the terms of your mortgage payment. Homeowners try loan modification to avoid foreclosure, which is way worse for your credit score.
Who Can Qualify for a Load Modification?
Although qualifying for load modification is not as challenging as qualifying for refinancing, you still need to meet some criteria before trying to change anything about your mortgage terms.
As we mentioned before, people looking forward to applying for load modification need to be suffering from a financial crisis. Nonetheless, this is not the only thing your loan servicer will ask you for. You also need to show them that you can't pay for your current loan payments, so they may ask for your bank statements.
It's useless to change your predictable monthly payment terms if you won't be able to pay for your loan after you modify it. Hence, you also need to prove you have enough funds to pay your monthly payments after getting the loan modification you want.
Regardless of the bank statements you show or the financial hardship you go through, you can't qualify for a loan modification on any properties apart from your primary residence.
Is It Difficult to Qualify for a Refinance?
The short answer is yes; qualifying for a refinance is highly difficult, and not many people achieve it.
People applying for refinancing need to have enough home equity and a qualifying credit score. Some loan companies may even ask you to have a 600 credit score to qualify, so try to set that straight before trying anything. Your current mortgage loan has to be in good standing before you try to replace it.
Even if you already have enough cash to cover the refinancing process, you need to prove it and show you have a decent debt-to-income ratio.
Is There Any Alternative to Loan Modification and Refinance?
If you are looking for a faster alternative to loan modification and refinancing, you should think about trying mortgage forbearance.
This process allows you to catch up to your debt in smaller payments to help you recover from a financial crisis. You can even put your payments on hold for a time until you get enough money for them. Nonetheless, you will have to pay for everything when the time comes.
Who Should Try Mortgage Forbearance?
Mortgage forbearance is ideal for people who don't have enough money to pay for their mortgage payments but need a faster alternative than a loan modification. This will only work for a time, so you need a plan to get things back on track after the forbearance period ends.
You should think about trying this alternative if:
- Your boss reduced your work hours.
- Your boss fired you.
- You are going through a divorce.
- You are severely sick or injured.
Bottom Line - Loan Modification vs. Refinance
The loan modification vs. refinance debate is not that difficult to settle once you understand how both processes work. Go for a load modification if you are going through an emergency and a refinance if you want to save money for the future.
We recommend you get help from a professional who can guide you through the application process for the option you choose.